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State Aid to European Banks: Returning to Viability Guillaume Adamczyk and Bernhard Windisch

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State Aid to European Banks: Returning to Viability Guillaume Adamczyk and Bernhard Windisch Issue 2015-01 | February 2015 ISBN 978-92-79-45368-7, ISSN: 2363-3468 Competition State aid brief Occasional papers by the Competition Directorate–General of the European Commission State aid to European banks: returning to viability Guillaume Adamczyk and Bernhard Windisch Introduction In a nutshell From 2007 onwards, the European Union faced the most serious Since the beginning of the European financial crisis, EU financial crisis since its creation. The Commission played a very countries have provided €671 billion in capital and repayable active role in dealing with the European sovereign crisis, and loans and €1 288 billion in guarantees 1 to financial swiftly adapted the State aid framework to put in place an institutions in distress, subject to EU State aid rules. Between effective response to the financial crisis. The Commission made 2007 and 2014, DG Competition has taken more than sure that banks were restructured or resolved under State aid 450 State aid decisions, determining the restructuring or rules, which preserved financial stability and the integrity of the internal market. This laid the foundation for the banking system orderly resolution of 112 European banking institutions2. to be able to resume its pivotal role in providing credit to the real In this State aid brief, we evaluate the effectiveness of these economy. restructuring measures. The results are striking: Don't be afraid of the numbers… (1) Around 25% of the entire European banking sector has been restructured under EU State aid rules. The Commission Since the beginning of the financial crisis , 112 banks in the EU, representing around 30% of the EU banking system by assets, reviewed State aid granted to some of Europe's biggest 3 financial institutions. Out of the top 20 European banks, the have received State aid . The aid provided in cash expenditure represents 5.4% of the EU's GDP in 2008 (or €671 billion in Commission approved aid to 12 banks, of which six were capital and loans injected into banks) and 10.3% in contingent subsequently restructured, five received aid through approved exposure (or €1 288 billion of liquidity and asset guarantees aid schemes, and one was orderly liquidated. provided to banks). To overcome the risks to financial stability, (2) This aid has paid off. Supported and restructured banks almost all Member States have made State aid available. In fact, are showing significant improvement in operational and risk in quite a few countries, more than half of the banking sector has indicators, and in funding and solvency positions. However, received State support4. The Commission approved restructuring the recovery is a time-consuming process. It is only towards plans for 56 of these banks, agreed on plans for orderly wind- the end of the restructuring period that the performance of down for 33 banks, and reviewed the viability of 14 others restructured banks converges towards the values of banks without further need for a restructuring plan. As of December that did not receive aid. 2014, the Commission was in the process of assessing the viability and restructuring of 9 banks. (3) Results from the recent asset quality review and stress test conducted by the ECB on the main European banks Has it worked? confirm these findings. Most banks under State aid control Because of the importance of the restructured banks to the successfully passed the test confirming their solvency. Ten European banking system and the significant amounts of aid banks under State aid restructuring that failed the exercise granted, it is essential to know how effective the EU-approved are only in the first couple of years of restructuring plan restructuring measures have been. It is critical to know whether implementation. If the Single Supervisory Mechanism accepts the restructured banks are returning to long-term viability all capital-generating actions implemented in 2014, only two without further need for aid, and especially whether they could of these banks will have a net capital shortfall, and one has announced recourse to private measures to fill the gap. 3 112 banks have been examined individually with respect to State aid received. This excludes cases receiving State aid under a governmental scheme but in amounts smaller than the relevant thresholds above which a separate notification would have been required. Note that the specific conditions for notification have evolved during the crisis. 4 Overall, 22 Member States provided aid to the financial sector. In Belgium, 1 Total of peak amounts of outstanding guarantees issued by each Member State. Cyprus, Greece, Ireland, Netherlands, Portugal and Slovenia, more than 50% of 2 Figures date from December 2014. the financial system by assets has received State support. KD-AM-15-001-EN-N, doi 10.2763/593657 Competition State aid briefs are written by the staff of the © European Union, 2015 Competition Directorate-General and provide background to policy Reproduction is authorised provided the source is acknowledged. discussions. They represent the authors’ view on the matter and do More publications on: http://ec.europa.eu/competition/publications and not bind the Commission in any way. http://bookshop.europa.eu State aid to European banks: returning to viability | Competition State aid brief withstand renewed stress in the banking system. This State aid What does long-term viability mean? brief presents answers to these questions5. According to the Restructuring Communication, "long-term viability is achieved when a bank is able to cover all its costs Viability requirements under State aid rules including depreciation and financial charges and provide an appropriate return on equity, taking into account the risk profile of 7 Three main pillars the bank. " In order to minimise costs to the taxpayer, it is essential to ensure that State aid is appropriately remunerated The Commission's assessment of bank restructuring plans under and eventually recovered by the State. To achieve this, banks the State aid crisis rules is built on three pillars6: must have the ability to generate a sustainable income and an appropriate return on equity. i. Restore long-term viability without further need for State support in the future, by restoring sustainable profitability The Commission examines a large number of elements in order and reducing risk; if this proves not possible, consider an to assess whether the bank will be able to generate sustainable orderly winding-down; income and manage costs and risks. The Commission conducts a fundamental review of the bank’s business model and identifies ii. Minimise the use of taxpayers' money, through the root causes of the bank's problems, finds the best path to an appropriate burden-sharing measures, including aid improved or new business model, and produces a technical remuneration and contributions by the bank, shareholders feasibility assessment and a stress scenario to ensure that the and junior creditors; bank can withstand shocks. The Commission also examines the quality of the bank's risk and credit management, and looks at iii. Limit distortions of competition through proportionate the bank's funding strategy and the development of its solvency remedies. Giving State aid to a particular bank can distort position. Last but not least, the Commission reviews the overall competition, as it gives the bank an advantage over its governance structure as well as the appropriateness of competitors. remuneration and incentive structures. Restoring long-term viability is key The restructuring plan needs to demonstrate on the basis of all This brief focuses on restoring long-term viability of aided, viable these elements that the bank can return to sustainable banks and the convergence of their performance towards that of profitability within five years. The key elements of the new their non-aided peers. We assess banks based on their overall business model are laid down in legally binding commitments in performance, taking into account the full implementation of the a Commission decision approving State aid endorsing the decision including the restructuring plan, i.e. of the three pillars restructuring plan. The proper implementation of the restructuring mentioned above. plan and commitments contained in it is subsequently monitored by trustees, acting as the Commission's "eyes and ears". Throughout the crisis, the Commission has stressed the importance of financial stability when implementing State aid Performance of aided banks compared to rules. Especially at the beginning of the crisis, exceptional market conditions made it necessary to ensure that conditions attached peers before and after receiving State aid to State aid to systemic banks would not create disturbances in Here we examine the performance of viable banks that received the financial markets. This is why State aid rules initially aid following Commission-approved restructuring plans compared permitted relatively generous conditions for granting State aid. to the peer group of unaided banks. The comparison is done by These conditions have been progressively adapted and tightened looking at the performance of aid recipients in "year zero" when in order to reflect changing market conditions and the evolving they first received aid, and the relative pre-aid and post-aid nature of the crisis. developments8. The comparison is based on key performance indicators relating to developments in operative and risk Restoring viability was, and remains, a fundamental element of management, overall profitability and capital and funding assessing banks in need of State support. Maintaining unviable positions. banks on the market would further impair the financial system and monetary transmission mechanisms, and create a medium- Adjusting costs to long-term risk to financial stability. It would also distort We assessed changes in operative management using the competition by crowding out viable banks capable of lending 9 capital to the real economy. When a bank is assessed as unviable operating income over total assets and the cost-to-income ratio and unable to be turned around on the basis of a credible as indicators.
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